Dom Post article: Defending the Bank
Did an article on why we should leave the Reserve Bank Act alone in the Dom this week. Given I’m too lazy to put up new material this morning I will just link to it (on Rates Blog, on the Infometrics site).
Money quote:
Warping the Reserve Bank Act to focus on a multitude of different goals will not solve these underlying issues; it will just cloak the symptoms by damaging other sections of the economy. Although pretending to solve an issue may be beneficial for politicians, it is not the best way to run New Zealand economic policy.
Update: A bit of pointless filler – again because I’m not up to writing anything fresh today 😉
On the fixed exchange rate
It appears that the idea of a fixed exchange rate has been risen, again.
Now the suggestion in here does take into account the impossible trinity – so it is theoretically possible. We have:
- Monetary policy can impact on output and inflation,
- The exchange rate is fixed,
- Capital flows ARE LIMITED
That third one is the kicker. Two issues I have here are:
- Limited capital flows implies that interest rates will rise (as for the previous interest rate there is a shortage of capital relative to demand). This implies that our functioning monetary policy that controls inflation must have higher interest rates and lower output.
- Limiting capital flows is pretty difficult for a small open economy like New Zealand.
On the balance of evidence and theory I would say that I strongly disagree with this proposal.
Update: BK Drinkwater comments here. He rightly points out that a less volatile currency isn’t obviously a good thing – it is the movement in export prices and whether they represent actual changes in relative prices that matters.
Agreement or no?
David Cunliffe has stated that new prudential regulation by the Reserve Bank shows that they agree with Labour on the need to dump the monetary policy consensus.
I would say no.
Monetary policy and prudential policy need to be treated separately. In the same way that fiscal policy and monetary policy are. Monetary policy (achieved through interest rates) should stick to the consensus view of keeping inflation expectations anchored.
Prudential policy is meant to ensure that we have bank stability. In this sense there may be some quantifiable social cost associated with systematic risk in the banking system, and that policy looks to internalize that risk. Now, there may be a role for this – or I’ll go out on a limb here and say that there may not be. However, this IS NOT an issue of monetary policy in the narrow sense.
Does prudential policy indirectly influence interest rates and the money supply – yes. So does fiscal policy. So does consumer confidence. So does risk preference in society. However, it is not monetary policy and it is not part of the reason for the Reserve Bank Act that Labour seems interested in tinkering with and adding “other goals too”.
I am not against Labour thinking about prudential regulation and other issues of policy. I am against them trying to use actual monetary policy to achieve multiple goals, and I am against trying to use monetary policy to achieve any goal other than a stable and low inflation rate. These issues NEED to be separated when discussing policy, or else we risk destroying a fully functional Reserve Bank Act.
Dear Rod Oram
I read your article on monetary policy in the Sunday Star Times (thanks to a link from Rates Blog). I disagreed with many of the things you said, but I really don’t think our conclusions are that separate when we look through the issues. First on my disagreements:
- I don’t agree that monetary policy needs to change (so an opposite conclusion in some ways),
- It isn’t up to monetary policy to tame housing bubbles – we should be asking where the bubble came from,
- The high OCR didn’t cause the high exchange rate persee – it is more likely that some other factor was causing both (say strong demand for housing, which is based on other fundamental factors).
- The “speed” of the domestic and international concept has very little to do with anything, neither does the size of trade in our currency.
- Capital inflows are not scary beasts – it just means people are lending to us. We should be asking why people are borrowing domestically and why that is too high (something you do get to at the end of your article).
- Prudential regulation is not monetary policy and is not part of the RBA in itself – I guess this means you would call me a purist. However, we need to make the distinction between the two clear, or else we muffle the signals of monetary policy and make the good outcomes associated with this policy difficult to achieve. My solution, separate the two cleanly – at least in terms of the statements they make. That way people know what is what.
- I agree that ultimately there are imbalances in the economy, and we need to adjust other forms of policy to improve them. Threatening the RBA in order to try and “achieve this” is not good – and should be shut out right now.
- When central bankers from Brazil don’t like the capital inflow tax (and they do it) it makes me suspect there is something wrong. By taxing inflows we are constraining our own borrowing – if people are borrowing on the basis of actual costs and benefits then taxing it will hurt the economy. It is better to look at the domestic issues influencing this then throwing in an arbitrary tax.
- A more stable exchange rate means more volatile export prices for most exporters – I don’t see how this is a good thing …
- Finally, we aren’t a centrally planned economy, and neither is the global economy. Talking about “running the economy” in this sense doesn’t make much sense in itself – we should be looking at how our policies influence the choices, and ultimately the welfare of, our citizens.
Ultimately, we can make a case for a change in prudential regulation and tax policy in New Zealand on the basis of our completely different assumptions. However, I don’t agree with the blame you have placed on the shoulders of the OCR. Monetary policy is being blamed for a bunch of bad policy both domestically and internationally, blame it does not deserve. It is receiving the blame because it can’t really answer back for itself.
So lets sit down and try to figure out the real issues the could be hurting New Zealanders, instead of running with the monetary policy scapegoat.
The carry trade and mortgage rates: Shifts and movements
Anyone who has done first year economics will know about shifts and movements. When I tutored the course I would make funny hand gestures trying to illustrate it, hand gestures that were mildly less weird then when I talk about price floors and ceilings.
Still, there has been a lot of banging on about the carry trade and mortgage rates, and I think some of it stems from a little confusion regarding shifts and movements. As an example I’ll work with this post from the Standard (ht BK Drinkwater).
Note: This is being added to the inflation debate, as a discussion of interest rate determination in a small open economy. Starting from the bottom, the combination of posts under that tag gives a fuller idea of what we are talking about with inflation targeting and our (narrow) view of monetary policy.